When the Securities Board of Nepal (SEBON) announced its plans to introduce Book Building System in Nepal, the investors in the country were ecstatic. It would allow investors to participate in the process of price discovery, rather than merely accepting set prices that were decided on the basis of par value or premium. It would also make the pricing process more competitive and transparent.
What is Book-building and how does it work?
Book building is the process by which an underwriter attempts to determine the price at which an initial public offering (IPO) will be offered. An underwriter or issue manager, which is normally an investment bank or a merchant bank, builds a book by inviting institutional investors (such as fund managers and others) to submit bids for the number of shares and the price(s) they would be willing to pay for them.[1]
As per the Book Building Directives 2077, the process of book building will work in the following method:
- The issuing company appoints an issue manager, who would be responsible for deciding a tentative price, and issue quantity. The issue manager would also prepare a draft prospectus as per the requirements of SEBON.
- The issuing company would invite Qualified Institutional Investors (QIIs) for a discussion program, known as roadshows, and receive letter of intent, indicating intended price and quantity. There needs to be a minimum of 10 QIIs participating in the book-building process.
- Based on the intended price received from the QIIS, the base price would be decided price band would be fixed at +/- 20% of the base price.
- Final prospectus would be filed with SEBON mentioning the quantity of shares to be issued and the price band, for final approval.
- After approval, formal bids from QIIs are invited.
- Successful bidders are selected, starting from the highest bids to the Cut-off price, which is the lowest price at which the shares will be sold. The shares will be sold at the cut-off price. It will be further issued to the general public at a discount of 10%.
Shares shall be issued to all the QIIs whose bidding price is at or above the cut-off price, at the cut-off price. Investors whose bidding price is lower than the cut-off price shall not receive any shares. For example, the book building process would be as follows if ABC Limited wants to issue 10,00,000 shares.
| Number of QII applicants | Bidding price | Bidding quantity | Cumulative quantity | Remarks |
| 5 | 250 | 50,000 | 50,000 | |
| 8 | 245 | 2,00,000 | 2,50,000 | |
| 15 | 235 | 2,50,000 | 5,00,000 | |
| 10 | 230 | 2,75,000 | 7,75,000 | |
| 21 | 225 | 5,00,000 | 10,00,000 | 225 will be the cutoff price since it has the maximum number of applicant i.e. 21. The remaining 2,25,000 shares will be split proportionately between 21 investors. |
| 20 | 215 | 3,00,000 | ||
| 18 | 205 | 1,50,000 | ||
| Total = 97 | 17,25,000 |
Investors who have bid for prices below 225 (below the cut-off price) will not be allocated any shares. This was the case of oversubscription. However, if the shares are undersubscribed, the underwriters are required to buy the remaining shares.
How does the process work for retail investors?
After the initial process, retail investors are eligible to apply for a minimum of 50 units and receive a discount of 10% on the cut-off price that was decided upon by the underwriter and QIIS. For example, in case of the previous example, retail investors will be able to apply for a minimum of 50 units of ABC Limited at 202.5.
How does the process impact general investors?
It is often argued that book-building is a process that favors large buyers and institutional investors. The resources that institutional investors to analyze the bidding price are unmatched by retail investors. They also have better access to market information. Additionally, a retail investor may not have a strong financial backup to invest in the stocks issues under Book building. For example, a retail investor who could purchase 10 units of stocks at 1000, may be required to pay 3000 for the same 10 units, as stocks would be issued at a price based on demand. Small investors have limited funds available, which may discourage them from the stock market.
However, since the book-building process is not mandatory, and many companies will still issue IPOs at a par value of 100, a retail investor will not be pushed out of the market completely.
Conclusion
Book building is price discovery mechanism allowing IPOs to be issued in a fair manner, with greater participation of institutional investors and large buyers. It will also allow issuing companies to raise large amount of capital, and gain information regarding price from potential buyers. The use of book-building method for issuing IPO will make the price of shares more transparent and competitive. Additionally, in context of Nepal it may encourage companies of the real sector, namely manufacturing and tech companies to go public as they are no longer obliged to issue an IPO at a fixed price. This would introduce more manufacturing companies in the stock market.
Tanushree Agrawal is a BBA Graduate from Christ University, with a major in Finance. Her areas of interest are Mergers and Acquisitions, private equity, impact investing, and economic policy. She was previously associated with BankerBay, an investment banking firm in India, working with the M&A team. She is a former fellow at beed management.
